facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause
Government Report Highlights Confusion Over 401(k) Distribution Options Thumbnail

Government Report Highlights Confusion Over 401(k) Distribution Options

A recent government report highlights how confused 401(k) participants are when they have to decide what to do with their savings after leaving employment.

Government Report Highlights Confusion Over 401(k) Distribution Options

Tax rules require 401(k) plans (and 403(b) and governmental 457(b) plans) to provide a written notice when participants become entitled to a distribution that can be rolled over. The notice must explain they can do a direct rollover to an IRA or another plan and that a mandatory 20% will be withheld from their payment if they don’t do a direct rollover.

The IRS provides model notices that plans can use to satisfy this notice requirement. Plans typically send the model notice as an attachment to the distribution application form after a participant requests a distribution. But these model notices have been widely criticized as too complicated for the average plan participant to understand.

The SECURE 2.0 Act required the General Accountability Office (GAO) to issue a report to Congress on the effectiveness of the notices and to make recommendations on how to improve them. The GAO surveyed over 1,000 401(k) participants who, between 2019 and 2022, were eligible to do a rollover to another plan. 

The GAO report results are not surprising but are still disturbing.

The survey showed that over 80% of eligible participants did not know that they have four options after leaving an employer: Keep their funds in the existing plan; roll over the funds to a new employer’s plan; roll over the funds to an IRA; or take a lump sum distribution. Over 50% were unaware of the “keeping funds in the plan” option. The GAO said this lack of knowledge was probably because IRS regulations do not require that the notice given out to participants must include information about this option.

In addition, about 40% did not understand three basic tax consequences about distribution options: First, participants can retain the tax-deferred status of their savings by doing a rollover to another retirement account or by leaving funds in the plan. Second, if they take a lump sum distribution, they are subject to a mandatory 20% tax withholding and a 10% penalty if under age 59 ½. Third, if they do an indirect rollover, they must add additional funds to make up for withheld taxes and deposit the savings into a new account plan within 60 days to avoid taxes and possible penalties.

Particularly troubling is that only about 35% of participants received a notice before they made a decision about their 401(k) funds.

The bottom line is that the retirement plan distribution rules are extremely challenging. If you are leaving your employer and have 401(k) savings, by all means seek help from an experienced financial advisor.

By Ian Berger, JD
IRA Analyst
Ed Slott and Company, LLC

Christian Cordoba, founder of California Retirement Advisors, has been a member of Ed Slott's Master Elite IRA Advisor Group since 2007.

Copyright © 2024, Ed Slott and Company, LLC Reprinted from The Slott Report, 06/03/24, with permission. https://irahelp.com/slottreport/government-report-highlights-confusion-over-401k-distribution-options/, Ed Slott and Company, LLC takes no responsibility for the current accuracy of this article. 
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment advisor. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.